yARN: A Dell reboot

Is the deal structure good for the company's long-term health?

Putting rest to weeks of media speculation, Dell Inc. finally announced a deal to be taken private by its eponymous CEO, Michael Dell, and technology-focused private equity firm, Silver Lake.

The deal, worth about $US 24.4 billion in cash, will rank as one of the largest buyouts since the financial crisis.

The deal is expected to give Dell the ability to push its ongoing transition into the enterprise space, away from the pressures of the stock market. Michael Dell, who will continue as the chairman and CEO, also seems eager to stay involved in the business, leading its “transformation.”

At its heart, the “go-private” deal will give the PC maker and its management the ability to fly under the radar, and execute a strategy privately, away from the constant quarterly monitoring from shareholders and analysts.

It is yet unclear what Dell plans to do with some of its outstanding long-term debt, particularly its rated bonds. If they are redeemed, it’s likely Dell won’t have any obligations to disclose its financials in the future.

That should give Dell plenty of privacy and unregulated flexibility to do radical changes, without giving much away to its competition.

But it would be premature to assume that the signing of the deal means all will be smooth sailing for the company from now.

In the short-term, Dell faces possible shareholder backlash, as is typical in such take-private deals.

Indeed, one law firm, Levi & Korsinsky, has announced it is investigating if Dell’s board potentially violated its fiduciary duty and violated certain state laws in connection with the sale of the company to its CEO.

Dell’s transaction, expected to close in the second quarter, will be financed through debt from a club of banks, and equity contributed by Michael Dell, MSD Capital, an investment firm, Silver Lake, and a $US2 billion loan from Microsoft.

If the proposed deal falls through, it could put further pressure on Dell's financial performance and weaken its competitive position amid a declining PC business, one credit ratings agency has warned.

In the long-term, the heavy debt on the company’s balance sheet could prove to be the biggest stumbling block in case it needs extra cash to execute its promised transition to an enterprise business.

Its relationship with its new lenders will also dictate how much elbow room it will have to maneuvre strategy should things go sour.

Microsoft loan - a friendly gesture or strategic play?

The $US2 billion Microsoft loan is being touted by analysts as a move that could potentially impact how other OEMs view Microsoft given its new relationship with Dell.

In an analyst call, Dell boasted about its 30-year relationship with Microsoft. The loan essentially allows it to independently execute its long-term strategy, but Microsoft won’t get a direct role in the day-to-day operations of Dell.

From Microsoft’s perspective, an investment in a loan provides a less risky form of investment. But that also means that Microsoft gets limited upside if Dell does well in the future.

However, in the event Dell undergoes a debt restructuring, a scenario that often precedes a possible bankruptcy or a refinancing, the loan would give Microsoft obvious benefits and potentially earn it an equity position. Historically, several private equity-backed company restructurings have been followed by debt-for-equity swaps, giving lenders eventual ownership of the business.

Microsoft’s loan could well be a strategic and well-hedged move to invest in Dell on a future date.

Private or not, Dell still needs cash for a facelift

Dell has already made aggressive moves to transition into an enterprise-focused business model in part through a series of acquisitions. It is hoping to accelerate that strategy with the new deal.

Despite assurances by Dell that the deal won’t put too much of a debt burden on the company and it will be able to pay its debt comfortably, ratings agencies have warned that the debt-laden deal will hinder its ability to execute and complete its transition to an enterprise model, a move that requires further R&D investments and acquisitions.

Moody's Investors Service has put Dell under review and expects “a multi-notch rating downgrade” of its long-term rating of the company amid its continuing business challenges, and its anticipated debt.

"Dell's profile has weakened with a more aggressive financial philosophy, at the same time as Dell struggles to transform its business model away from lower end hardware and commoditised PCs to potentially more profitable data centre and enterprise solutions," Moody's senior credit officer, Stephen Sohn, said in a statement.

Moody’s also sees Dell's strategic transition to an enterprise-centric model as taking longer than anticipated. And this transitional strategy has been slowed by the secular decline of PCs, with PC sales still accounting for nearly half of revenues, noted Moody’s. It expects Dell's PC revenues will continue to erode in 2013 with potential revenue declines for the PC business of double digits.

For 2013, Moody's expects worldwide, industry-wide PC revenues to fall in the high single digits, with Dell trailing the pack of its primary competitors including Hewlett Packard, Lenovo, Acer, and Asus.

For Dell’s part, it claims that since FY08, it has shored up more than $US13 billion in over 20 acquisitions primarily in enterprise solutions. In FY2013, it acquired AppAssure, Clerity Solutions, Credant Technologies, Gale Technologies, Make Technologies, Quest Software, SonicWall and Wyse Technology.

It also boasts 13 R&D centres; with more than 75 per cent of its R&D spending going into enterprise solutions; and more than 7,000 solutions sales specialists.

Dell’s Enterprise Solutions and Services business contributed revenue of about $US 4.8 billion in the third quarter, up three per cent from the year-ago, partly helped by 11 per cent growth in its server and networking business. The business is now achieving an annual run-rate of nearly $US 20 billion, year-to-date and has generated more than 50 per cent of its non-GAAP gross margin year-to-date, according to Dell.

All that points towards a good transition, but only time will tell if it will be enough to stem the decline of its PC business and put it back on a solid footing.

Of course, a few years down the road Dell could re-list on the stock exchange as a very different company, or see owners change hands, again.

Rimin Dutt is Senior Editor of ARN. She formerly worked as a private equity reporter for Dow Jones in the US and a senior mergers and acquisitions journalist at the Financial Times Group in Sydney.

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